With this background it will be possible to appreciate the real economic nature of interpositioning.
THE CONFLICT: THE COURTS' AND THE GOVERNMENT'S ANALYSES OF INTERPOSITIONING AND FRAUD
On the one side, the court decisions that culminated with Finnerty III (174) ruled that specialists' interpositioning was not a fraud in violation of Rule 10b-5.
183) At this point, the courts agreed that, in principle, interpositioning could be found to be a form of fraud because customers likely did not expect that their trades would not be getting the best price, when the rules of the exchanges spoke to the contrary.
The last judicial opinion on interpositioning came with the appeal of the Finnerty II decision to the Second Circuit, Finnerty 111.
220) The government similarly argued that interpositioning was a fraudulent scheme, and therefore a violation of Rule 10b-5 subsections (a) and (c).
Even before the issue went to the federal courts, the SEC found that interpositioning had violated Rule 10b-5, (222) Unfortunately, as these were settlement proceedings, (223) the SEC did not undertake much of a legal analysis of the situation.
A student note predating the interpositioning prosecutions states that when a specialist is trading on behalf of a customer, she has a fiduciary duty to that customer.
Finally, in an ongoing class action against specialists, the Southern District of New York suggested that knowledge by specialist firms of their employees' interpositioning was sufficient to show scienter on the part of the firms.
Interpositioning has been called arbitrage, (252) and arbitrage is generally a good thing.
One might argue that specialists have always understood that part of their income to be interpositioning income and that indeed this is what makes a firm agree to such an arrangement with an exchange.
294) This way, either there would be no interposition, or the customers would be able to take into account the interpositioning and make bids and offers that at least took interpositioning into account.